Public Spending – The End of Austerity?

Cricket fans look forward to the Ashes, racegoers to the Grand National but for economists, the year has two highlights, namely when tax and public spending changes are announced. This is particularly the case for Keynesian economists who see the balance between taxation and government spending as the key determinant of the level of aggregate demand. Last week saw the Chancellor set out the government’s public spending plans for departments for 2020 – 2021. Possibly (and cynically) with an election looming, he announced the end of austerity with an increase of £13.4bn or 4.1%  in government spending. All areas would rise at least in line with inflation, with the main beneficiaries being the field of law and order (police, prisons and courts), defence, health and education. The increased spending will mean that the government’s share of GDP will increase for the first time since 2009.  The money for this will come from borrowing which is predicted to increase from 1.1% to 2.0% of GDP but, even with the increase, this keeps the public finances in line with the previous Chancellor’s target of cyclically adjusted borrowing of no more than 2% of GDP.

The spending announcement has raised eyebrows in some quarters. This is partly because of the process. Paul Johnson, Director of the Institute for Fiscal Studies, writing in the Times, pointed out that, normally, public spending reviews are a long process, with ministers arguing their case to the Treasury and big decisions being made in Cabinet. Given that the date of the announcement was made only a week before it happened, he wonders whether there has been sufficient time for a thorough review of all the conflicting demands on the government’s limited resources. Another concern among commentators is whether the Chancellor will be able to meet his fiscal rule. Last week’s announcement heralded the largest increase in spending since 2004 and it is worth remembering that in 2004, the UK economy was booming. Today the rise in spending comes at a time when growth is likely to slow. Therefore we can applaud the increase in terms of a counter-cyclical measure but expect that the 2% rule will need to be re-written in the next few months.